I. Data Sources
II. Derivation of Equations for Estimated Output and Labor Demand
Artus, Jacques A., “Measures of Potential Output in Manufacturing for Eight Industrial Countries, 1955–78,” Staff Papers, International Monetary Fund (Washington), Vol. 24 (March 1977), pp. 1–35.
Artus, Jacques A., “The Disequilibrium Real Wage Rate Hypothesis: An Empirical Evaluation,” Staff Papers, International Monetary Fund (Washington), Vol. 31 (June 1984), pp. 249–302.
Basevi, Giorgio, and others, Macroeconomic Prospects and Policies for the European Community, Economic Papers, No. 12 (Brussels: Commission of the European Communities, Directorate-General for Economic and Financial Affairs, April 1983).
Berndt, Ernst R., and David O. Wood, “Engineering and Econometric Interpretations of Energy-Capital Complementarity,” American Economic Review (Nashville, Tennessee), Vol. 69 (June 1979), pp. 342–54.
Bruno, Michael, Raw Materials, Profits, and the Productivity Slowdown, Working Paper No. 660 (Cambridge, Massachusetts: National Bureau of Economic Research, April 1981).
Bruno, Michael, and Jeffrey Sachs, Macroeconomic Adjustment with Import Price Shocks: Real and Monetary Aspects, Working Paper No. 340 (Cambridge, Massachusetts: National Bureau of Economic Research, April 1979).
Bruno, Michael, and Jeffrey Sachs, “Input Price Shocks and the Slowdown in Economic Growth: The Case of U.K. Manufacturing,” Review of Economic Studies (Clevedon, England), Vol. 49, Special Issue (No. 159, 1982), pp. 679–705.
Buiter, Willem H., and Marcus Miller, “The Thatcher Experiment: The First Two Years,” Brookings Papers on Economic Activity: 2 (1981), The Brookings Institution (Washington), pp. 315–79.
Buiter, Willem H., and Marcus Miller, “Changing the Rules: Economic Consequences of the Thatcher Regime,” Brookings Papers on Economic Activity: 2 (1983), The Brookings Institution (Washington), pp. 305–79.
Dunlop, John T., “The Movement of Real and Money Wage Rates,” Economic Journal (Cambridge, England), Vol. 48 (September 1938), pp. 413–34.
Grubb, D., R. Jackman, and R. Layard, “Causes of the Current Stagflation,” Review of Economic Studies (Clevedon, England), Vol. 49, Special Issue (No. 159, 1982), pp. 707–30.
Lipton, D.A., Accumulation and Growth in Open Economies” (doctoral dissertation, Cambridge, Massachusetts: Harvard University, 1979).
Mundell, Robert A., “An Exposition of Some Subtleties in the Keynesian System,” Weltwirtschaftliches Archiv (Kiel), Vol. 93 (No. 2, 1964), pp. 301–13.
Otani, Ichiro, “Real Wages and Business Cycles Revisited,” Review of Economics and Statistics (Amsterdam), Vol. 60 (May 1978), pp. 301–04.
Sachs, Jeffrey D., “Wages, Profits, and Macroeconomic Adjustment: A Comparative Study,” Brookings Papers on Economic Activity: 2 (1979), The Brookings Institution (Washington), pp. 269–320.
Sachs, Jeffrey D., “Real Wages and Unemployment in the OECD Countries,” Brookings Papers on Economic Activity: 1 (1983), The Brookings Institution (Washington), pp. 255–89.
Tarshis, Lorie, “Notes and Memoranda: Changes in Real and Money Wages,” Economic Journal (Cambridge, England), Vol. 49 (March 1939), pp. 150–54.
Mr. Lipschitz, a senior economist in the European Department, holds degrees from the London School of Economics and Political Science and the University of London. This paper was written while he was on leave from the Fund as a guest scholar at the Brookings Institution.
Ms. Schadler, a senior economist in the Asian Department, holds degrees from Mount Holyoke College and the London School of Economics and Political Science.
The authors wish to acknowledge comments on the paper by colleagues in the Fund and by Harold Furchgott-Roth, Kazumasa Iwata, Robert Lawrence, Yuzuru Ozeki, Yoichi Takahashi, and Heizo Takenaka.
Enormous debts to work done outside the Fund will also be apparent to the informed reader. In particular, papers by Sachs (1979), Bruno (1981), Bruno and Sachs (1979 and 1982), Grubb, Jackman, and Layard (1982), and Basevi and others (1983) have been extremely helpful.
Throughout this paper, real wages and real prices of raw materials refer to nominal wages and raw material prices that are deflated by the price of manufactured output. These terms should be distinguished from nominal wages or materials prices that are deflated by consumer prices. The latter are relevant to wage earners or consumers, the former to producers.
If output prices responded to demand while nominal wages were relatively sticky, a further demand expansion might indeed be effective in reducing real wages. Insofar as workers are in a position to restore the real wage level to W0, however, the gain will be only transitory. The characterization of the “Keynesian” view in this section refers to modern Keynesians rather than to Keynes himself. The classical view that real wages are countercyclical was actually retained by Keynes (see The General Theory (1936), Chapter 20), but has since been the subject of great debate; see, for example, Dunlop (1938), Tarshis (1939), and Malinvaud (1977). Otani (1978) provides a useful examination of the recent data, and Sachs (1983) has an excellent discussion of this point.
For the purpose of this exercise, labor and raw materials are assumed to be variable inputs, whereas the capital stock is assumed to be fixed in the short run. Despite lifetime employment practices affecting many workers in Japan’s manufacturing sector, labor can be viewed as a variable input because of the substantial variations in average working hours and the flexibility with which a large number of young women enter and leave the work force.
where ρ1 = (σ1 − 1)/σ1 and ρ2 = (σ2 − 2)/σ2, and σ1, σ2, are elasticities of substitution between labor and capital, and between value added and raw materials, respectively. V is value added, RM the raw materials input, and N the labor input. Several simplifications implicit in this model should be noted: (1) the aggregation of energy and other raw material inputs ignores possible differences between the effects of changes in their prices; (2) all technological progress is labor saving; and (3) the degree to which technology is capital intensive (as indicated by a) and raw material intensive (as indicated by b) is fixed over the time period. For an examination of bias resulting from some of these simplifications, see Artus (1984; this issue). Appendix II provides a detailed derivation of equations (1) and (2) from profit maximization, subject to these production functions.
For Japan, gross national expenditure was used; for the United Kingdom, gross domestic expenditure was used. The t2 is included to capture the slowdown in growth during the sample period.
The mean of the ratio of the value of labor to capital inputs (α/γ), which is available from national accounts statistics, was imposed in the estimation to improve the efficiency of results.
The coefficient on t2 was not significantly different from zero in preliminary estimation results for Japan and was dropped from the final estimation.
For example, a zero elasticity of substitution implies that the given technology allows no substitution to occur. An increase in the relative price of raw materials simply leads to a corresponding increase in the share of raw materials in total costs, which must be offset by a lower share for labor and for capital. An elasticity of substitution equal to unity implies that a given increase in the relative price of raw materials would lead to a proportionately equal decline in the volume of raw material inputs so that the shares of labor, capital, and raw materials in total costs would remain constant.
Gross output is defined as output of manufacturing industries, less the part of output that serves as an intermediate input into other manufacturing industries. Raw material and fuel inputs in 1974 constituted 17.8 percent of gross output. The estimated share (β), adjusted for relative price changes given the estimated elasticity of substitution, amounted to 16.8 percent in 1974 and 18.3 percent in 1975. This is remarkably close to the input-output coefficient.
This is oversimplified, insofar as only three factors are admitted. In fact, the share of value added is somewhat lower when inputs of other sectors—such as services, construction, and the like—are allowed. It is implicitly assumed that the prices of labor and capital move similarly in these sectors and that the share of raw materials in these sectors is negligible.
For each country, the wage gap index is simply an index of the actual over the warranted real wage level.
The size of the wage gap is, of course, extremely sensitive to the assumption about the labor supply. The methodology employed by Artus (1984) implicitly incorporates the effects of structural change in the estimates of the labor supply. This is not particularly important for Japan, for which—despite the differences in methodology—the two studies find almost identical absolute increases in the wage gap over the period 1963–82 (although the timing of the movements in the wage gap differs for reasons detailed in Artus’s study). For the United Kingdom, however, by incorporating the calculated effects of structural change on the labor supply available to manufacturing, Artus finds a much smaller wage gap than is found in the present study. Indeed, according to his results, the absolute increase in the wage gap for the United Kingdom during 1963–82 is about the same size as that for Japan.
The rate of change in real terms fell from −1 percent a year in 1973–75 to −5 percent a year in 1976–77.
It should be clear that the partial equilibrium nature of the estimated model prevents a firm conclusion on the sustainability of gains from more expansionary demand management policies. The analysis in this paper is designed, rather, to assess the relative cost position of manufacturers as one factor that could limit the effectiveness of such policies for countercyclical purposes.
The use of two-tier production functions does have certain restrictive implications for substitution among the three factors of production. For example, the separability of raw materials implicit in the two-tier production functions ensures that an increase in the price of raw materials reduces the demand for labor. If the three factors of production were included in a single production function, this would not necessarily be the case. Various empirical studies of the United States and Japan, however, suggest that the restrictive form of the production function is not inconsistent with the data. See Berndt and Wood (1979) and Lipton (1979).